Israel has launched a major reform of its credit card industry in a shakeup that has wide-ranging implications for consumers — despite several false starts, opposition from vested interests and skepticism from independent observers.

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The recent passage of the Law for Increasing Competition and Reducing Concentration in the Israeli Banking Market by the Knesset (parliament) marks the biggest structural change in the banking sector since the ‘Bachar reform’ of 2005 — named after Yossi Bachar, former finance ministry director general — which required commercial banks to divest their asset-management subsidiaries. These reforms resulted in a far-reaching shake-up of the pension, insurance and investment sectors.

The new law — based on recommendations from a committee chaired by Dror Strum, former head of the Antitrust Authority — aims to open up the financial sector to more competition to benefit consumers. It fulfills one of the campaign promises of a new centrist political party, Kulanu, led by Moshe Kahlon, which won 10 out of 120 seats in the 2015 Knesset elections. Due to Israel’s proportional representation system, the seats were enough to give Kulanu the balance of power in a Likud-led coalition and enabled Kahlon to lead the powerful finance ministry.

The central feature of the new law is the requirement that the two biggest Israeli banks — Hapoalim and Leumi — divest their credit card subsidiaries. Yet, this obligation is less sweeping than the Bachar reform, in which all banks were effectively expelled from the asset management sector. This time, the divestment is limited to Isracard and Leumi Card, the two main credit card companies and hence the dominant players in the sector, which are owned by Hapoalim and Leumi respectively.

However, the third major card company, Cal, is currently not included in the restructuring. It is owned by Israel Discount Bank and First International Bank, the third- and fifth-biggest banks, with 72% and 28% stakes, respectively.

Turf Wars Behind the Scenes

Cal’s fate generated one of the fiercest struggles in the new law’s deliberations and during the legislative process, because Kahlon and the ‘reformist’ camp wanted it included in a complete shake-out of the current players. However, the ‘conservative’ camp, led by the Bank of Israel (the central bank), demanded that credit card reform be viewed within the overall structure of the banking industry.

“Israel has launched a major reform of its credit card industry in a shakeup that has wide-ranging implications for consumers.”

“The whole move (of restructuring the credit card sector) must be done in a balanced way,” explains Ilanit Madmoni, head of innovation in the financial technology unit of the banking supervision department at the Bank of Israel. “We insisted that a distinction be made between the two big banking groups and the Israel Discount group. Detaching Cal from Discount would be a much greater blow to it than would the loss of Isracard and Leumi Card to their parent banks, and could even pose a threat to Discount’s stability. Conversely, allowing Discount to retain Cal would narrow the gap between it and ‘the big two’ — and thereby improve the overall competitiveness of the banking sector.”

The outcome, as reflected in the final version of the law, was a compromise — but one that leans heavily towards the Bank of Israel, which dug in its heels and “made Cal into a ‘red-line’ that could not be crossed,” Madmoni says. Instead of requiring the sale of Cal, the law stipulates only that its status be reviewed in four years — by which time Isracard and Leumi Card must be sold. The new structure of the sector should also be clearer by then.

The fight over Cal was one of numerous clashes between the different regulatory bodies represented on the Strum committee. Probably the most important turf war, at least from the viewpoint of the ministries and agencies involved, was over how and by whom the divested credit card companies — as well as any new ones — would be regulated. In this respect, the finance ministry emerged victorious, because the new regulatory entity charged with overseeing consumer finance is to be established within the comptroller of pensions, insurance and capital markets — a department within the finance ministry.

Meanwhile, Hapoalim and Leumi were given three years to divest Isracard and Leumi Card, either by being spun off, or sold to strategic or financial investors. If they choose the former route, the law allows them to sell 60% of their stake within three years and to complete the process in the fourth.

Following the sales, the two big banks will not be allowed to engage in clearing operations for credit cards, but they will still act as issuers — as banks do all over the world. Many of the new law’s provisions — such as the stipulation that every bank must contract to work with at least two clearing companies in a fair and transparent tender process — are connected to the detailed implementation of the goal of opening up the clearing process to competition.

As for the credit card companies themselves, the law puts in place a ceiling of 52% for any single company’s market share. Currently, Isracard is close to the market share cap, holding about 50% of the market compared to Leumi’s 26%. Overall, the divestiture of the big credit card companies “is a blow, but not a major blow,” to the banking sector, according to an adviser to the big banks.

Opening Up the Credit Card Market

The bigger impact of the law is the opening up of the consumer credit market to new entrants. At present, commercial banks dominate both the mortgage and non-mortgage lending to consumers with a combined market share of more than 90% as of September 2016, according to Bank of Israel data.

While the mortgage sector is fiercely competitive, pushing lending margins to very low levels, the non-mortgage lending market has much fewer competitors, according to central bank and independent analysts. And the size of the non-mortgage consumer credit market is a big prize: It comprises 11% of the typical Israeli household’s debt.

The combination of less competition and significant market size makes the credit card sector attractive to potential entrants. It is this concept that underpins the reform — yet realizing this potential is no guarantee. That’s why simply requiring divestitures of credit card subsidiaries was deemed insufficient without addressing other issues.

The first major hurdle facing any would-be entrant into the credit card sector is the need for credit data. In the existing system, where the commercial banks effectively “own” their household customers, the line of credit extended by the bank’s credit card company to a cardholder is part of its overall relationship with that customer. How much credit is made available is decided by the customer’s branch and is either a supplement or an alternative to an overdraft facility (a near-ubiquitous feature of Israeli household finance).

This is a very cozy relationship for the bank, because it knows its customers and has ample data on them. But it is a very constricting relationship for the customer, because the data is proprietary — so customers seeking to switch to rival banks must effectively start from scratch.

Thus, an essential prerequisite to

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